Equity release sector in deep trouble, report finds

The equity release sector is in deep trouble with the regulator having missed opportunities to effectively manage the risks in the market, a report from the free-market Adam Smith Institute has claimed.

‘Asleep at the Wheel: The Prudential Regulation Authority and the Equity Release Sector’ revealed that firms are greatly under-valuing their no negative equity guarantees – guarantees that ensure that borrowers’ debt can never exceed the value of the mortgaged property.

The report said these problems have been well-known to the regulator, the Prudential Regulation Authority, for years and the regulator has knowingly allowed firms to use valuation methods that are unfit for the task.

Professor Kevin Dowd, author of the report, and professor of finance and economics at Durham University, said: “Nearly two decades and one global financial crisis later it seems like history is repeating itself.

“We never seem to learn. Equitable Life hit the rocks two decades ago because it under-valued its long-term guarantees.

Now the equity release sector is said to be in deep trouble for the same reason. In both cases, the firms involved got into difficulties because they were using voodoo valuation methods that had no scientific validation. Same causes, same results.

“In the aftermath of the Equitable Life fiasco we were assured that lessons had been learned and the vastly expensive Solvency II regulatory regime was installed to ensure there would never be a similar disaster in the future.

“The PRA and Solvency II have failed spectacularly. The most astonishing thing about this scandal is that the PRA knew about these poor valuation practices but permitted them anyway. It would be interesting to know why.”

Professor Dowd said that the equity release fiasco is yet another case of incompetent management, undervalued long-term guarantees and regulators who are not up to their jobs.

The UK’s equity release market had nearly trebled in size between 2012 and 2017 and had been forecast to grow a further 40% by 2020.

PRA stress tests in 2017 indicated that a 30% house price fall could lead to losses of between £2bn and £3bn, with the exposures skewed towards firms with larger house price or ERM exposure.

The report argued the Prudential Regulatory Authority is confused about the capital requirements it imposes upon the industry.

When asked at a parliamentary Committee in 2017 about the size of these capital requirements, deputy bank governor Sam Woods suggested the requirement was £126bn, while moments later his colleague David Belsham suggested it was just £80bn.

The Treasury Committee was accused by professor Dowd of botching its scrutiny of the impact of Solvency II on insurance companies, and having been captured by corporate lobbyists.

The report added that the regulator, the Prudential Regulation Authority, has itself made half-hearted efforts to address this under-valuation problem. Yet for years the PRA failed to rein in firms that continued to use inadequate valuation methods for their no negative equity guarantees.

It went on to say that in most financial regulatory scandals the regulators are caught off-guard and never see the problem coming. In this case, not only did the regulator identify the problem of poor NNEG valuation practices years ago, but the PRA allowed them anyway.

The report questioned the Prudential Regulation Authority’s capacity to regulate the industry competently.

The Dowd report follows a joint investigation with BBC business journalist Howard Mustoe.